Press release: Transfer duty exemption and corporate transactions
Provisions allow certain transactions to take place without immediate adverse income tax.
The Income Tax Act, No. 58 of 1962 (“the ITA”), contains certain provisions colloquially referred to as “the corporate roll over provisions”. In short, these provisions allow certain transactions to take place without triggering immediate adverse income tax (including capital gains tax), VAT, Transfer Duty or Securities Transfer Tax consequences. The taxes that would have had to be paid were it not for these special rules is effectively deferred until a later stage provided all requirements are satisfied.
These provisions include section 42 (asset for share transactions), 44 (amalgamation transactions), 45 (inter group transactions), 46 (unbundling transactions) and 47 (liquidation distributions). Transactions that satisfy the requirements of these sections typically qualify for relief from other taxes such as transfer duty. We will look into the transfer duty exemption specifically in relation to transactions that qualify as asset for share transactions in terms of section 42 of the ITA as well as the absence of any specific exemption for unbundling transactions in terms of section 46 of the ITA.
Asset for share transactions
Section 9(1)(l)(i) of the Transfer Duty Act, No, 40 of 1949 (“the TDA”), provides for an exemption from transfer duty in respect of the acquisition of property by a company if such property was acquired in terms of an asset for share transaction per section 42 of the ITA.
Section 9(15A) of the TDA, similarly, provides for an exemption from transfer duty for the acquisition (invariably by a company) of property if such property was acquired under an asset for share transaction. There is, however, a slight difference between the two provisions:
- The exemption in section 9(1)(l)(i) of the TDA provides a blanket exemption, the only requirement being satisfaction of the requirements in section 42 of the ITA; and
- The exemption in section 9(15A) provides the exemption only if the requirements of both section 42 of the ITA as well as the requirements of section 8(25) of the Value Added Tax Act, No. 89 of 1991 (“the VAT Act”) are complied with.
The interpretation of the two almost identical provisions in the TDA is not problematic if both the requirements of section 42 of the ITA as well as the requirements of section 8(25) of the VAT Act are complied with. It does, however, become difficult when section 8(25) of the VAT Act is not complied with. The following example illustrates:
Assume a company owns only residential properties from which it earns rental (it has no other activity, no other assets and earns no income other than rental income) and the directors and shareholders want to move the properties into a different company to ringfence risk associated with that particular trade. This can normally be achieved in a tax-efficient manner by way of an asset for share transaction under section 42 of the ITA (normally followed by an unbundling transaction to achieve the commercial aim). If the requirements of section 42 of the ITA are satisfied, the seller will not be liable for any capital gains tax (“CGT”) on transfer of the property (the CGT is effectively deferred until a later date). Will the purchaser, however, be liable for Transfer Duty?
Let’s start by checking if section 8(25) of the VAT Act will be complied with. The seller in my example is only making exempt supplies for VAT purposes (see section 12(c)(i) of the VAT Act) and therefore does not carry on any enterprise (see proviso (v) to the definition of ‘enterprise’ in section 1 of the VAT Act) with the result that it cannot be a VAT vendor. Consequently, section 8(25) of the VAT Act cannot apply to the transaction.
The purchaser in this example does not qualify for the exemption in section 9(15A) of the TDA which means transfer duty is payable. The purchaser will, however, qualify for the exemption from transfer duty in section 9(2)(l)(i) which means there is no transfer duty payable. The raises the question – which provision takes preference?
One could argue that the more specific provision is section 9(15A) of the TDA and that it should take preference. One should however, it is submitted, ask whether it was the intention of the legislature to only allow a transfer duty exemption for asset for share transactions if section 8(25) of the VAT Act is complied with. Let’s consider the history of the two provisions in the TDA:
- Section 9(15A) was inserted into the TDA during the 2005 round of tax amendments; and
- Section 9(1)(l)(i) (as it reads now) was inserted into the TDA during the 2011 round of tax amendments.
If the legislature had intended to only allow the transfer duty exemption if the requirements of section 9(15A) was satisfied, why insert a blanket exemption for asset for share transactions in 2011, without repealing section 9(15A) at the same time?
The explanatory memoranda to the bills or bills that eventually introduced section 9(15A) and section 9(1)(l)(i) seem to suggest that:
- Section 9(15A) was inserted into the TDA to overcome shortcomings with section 9(15) of the TDA in the event of a transaction qualifying for relief under section 42 of the ITA. Section 9(15) of the TDA exempts from transfer duty, any transaction that qualifies as a taxable supply for VAT purposes. Technically speaking, where section 8(25) of the VAT Act applies, the transaction is not a taxable supply because the supplier and the recipient is deemed to be one and the same person for that particular transaction. As such, section 9(15) would not have applied to an asset for share transaction if section 8(25) of the VAT Act applied, despite the general rule that VAT transactions should not fall subject to transfer duty. As such, a new section 9(15A) was required to ensure asset for share transactions that would have constituted VAT transactions were it not for the application of 8(25), qualifies for the transfer duty exemption.
- Section 9(2)(l)(i) was inserted after the different transfer duty rates for companies and individuals were abolished and after the avoidance mechanism of selling a share in a company as opposed to selling the property in the company was addressed with the introduction of the concept of “residential property company”. The explanatory memorandum goes on to state that: ‘ … tax-free “asset-for-shares” (e.g. formations) will now be permitted.’ (it is worth pointing out again that section 9(2)(l)(i) was inserted at a time when ‘tax-free “asset-for-shares” (e.g. formations)” were already permitted under section 9(15A)).
It seems then that the legislature intended for section 9(15A) to be applicable where the asset for share transaction is a VAT transaction and section 9(2)(l)(i) to be applicable where the asset for share transaction is not a VAT transaction. If this is the correct interpretation, then, in the example above, section 9(2)(l)(i) should apply to exempt the transaction from transfer duty, despite the transaction not satisfying the requirements of section 8(25) of the VAT Act.
An unbundling transaction, as envisaged in section 46 of the ITA, is a transaction in terms of which a company (hereinafter referred to as “the unbundling company”), distributes shares held in a subsidiary (hereinafter referred to as the “unbundled company”), to its shareholders, provided the other requirements of section 46 of the ITA are complied with. As with the other corporate rollover provisions, an unbundling transaction prevents an immediate adverse tax consequence for the unbundling company. In short, the unbundling company will pay no CGT and no dividends tax on the distribution to its shareholders provided all the boxes of section 46 are ticked.
In keeping with the general rule that corporate rollover transactions should not give rise to an immediate adverse cash tax consequence, The TDA provides an exemption from transfer duty for all corporate rollover transactions. Except, however, for a transaction contemplated in section 46 of the ITA – unbundling transactions. Whilst the omission of a specific exemption for section 46 transactions in the TDA has been said to be the consequence of the fact that, in an unbundling transaction, the asset being transferred will invariably be a share in a company, suffice it to say that (a) a share in a company can indeed constitute “property” for the purposes of the TDA and (b) the Securities Transfer Tax Act, No. 25 of 2007 (“the STT Act”) gives preference to the TDA.
Why then the omission? Why should unbundling transactions be treated differently from all the other corporate rollover provisions from a transfer duty perspective? Maybe it is simply an oversight? Perhaps not, if the transfer duty act cannot apply to such distributions:
- One argument could be that because the TDA can only apply where a person acquires property, the TDA cannot apply to unbundling distributions – the shareholder who will be getting direct control over the shares in the unbundled company effectively held the shares via the unbundling company before the unbundling transaction. There is accordingly no acquisition of property by the shareholder – or at least so the argument could go; or
- A different argument could be that when there is an unbundling transaction, there is no ‘transaction’ as defined in the TDA (no agreement, only a one-sided decision, and arguably also not a renunciation by the ultimate shareholder who has nothing more or less after the unbundling transaction than what it had before the unbundling transaction via the unbundling company) – or at least so the argument could go.
If either of the above interpretations of the TDA are correct, it would explain why there is no specific exemption for unbundling transactions. If neither interpretation is correct, it would suggest that unbundling transactions are simply subject to transfer duty. This could be a major tax consequence on a transaction that is for the purposes of all other taxes, tax neutral and could result in a significant exposure.